Academic journal article International Journal of Management and Innovation

Cross-Industry Determinants of Capital Structure: Evidence from Pakistani Data

Academic journal article International Journal of Management and Innovation

Cross-Industry Determinants of Capital Structure: Evidence from Pakistani Data

Article excerpt


Selection of an optimal capital structure is always a critical issue for every firm. The reason for this importance is of course financial risk and tax advantage which are directly influenced by company's choice of Capital structure. Therefore so many researchers investigated the relationship between capital structure and firm's value (Abor, 2007; Krishman & Moyer, 1997) Debate on capital structure started with the theory given by Modigliani and Miller (1958) according to them if there is no bankruptcy cost and tax benefit then firm's value would be independent of capital structure. But in reality there is a tax benefit of debt and bankruptcy cost so firm's value affected by capital structure. This issue tends to an optimal capital structure (Kraus & Litzenberger, 1973; Kim, 1978). Under the "the trade-off theory of leverage," firms face trade-off between tax advantage of debt and its bankruptcy cost. Up to the point where marginal tax benefit is higher the marginal bankruptcy cost, debt will increase the firm's value. But by increasing the amount of debt marginal bankruptcy cost increases and the point at which marginal cost equate the marginal tax benefit it is the point of optimal capital structure. According to packing order theory a firm do not follow the pattern of optimal capital structure infect firms finance their business in the pattern of internal sources to external sources of finance (Myers & Majluf, 1984). Baxter (1967) gave the same concept as tradeoff theory he argue that as the leverage of firm increases, firm's bankruptcy cost increases and creditor demand more risk premium. So a firm must use the debt up to the level where this cost is lesser than tax advantage. From last five decades so many researchers explored this topic and found different factors that affect the capital structure decisions of firms. Titman and Wessels (1988) state that structure of Assets, non-debt tax shields, growth, uniqueness, industry classification, size, earnings volatility and profitability are determinant of Capital structure. Harris and Raviv (1991) in their review article compare the different researches and found leverage increases with fixed assets, non-debt tax shields, growth opportunities and firm size and it decreases with volatility, advertising expenditure, R&D expenditures, profitability, uniqueness of the product and probability of bankruptcy. Bennett and Donnelly (1993) for nonfinancial firms found that non-debt tax shields, asset structure, size and profitability have strong impact of the firm's choice of capital structure. Literature suggested that debt requirement of a firm in one industry differ from the firm in other industry (Titman & Wessels, 1988). Bradley et al. (1984) empirically proved that there is a strong relationship among leverage and industry classification. Sinha (1993) stated that there is a strong inter-industry leverage variation in Indian firms. As the literature proves that the firms related to different industries shows different debt levels, so this study will investigate that is there any difference in determinates of capital structure among different industries.

Data and Research Design

Sample of our study includes firms from three different sectors (Textile, Energy and Cement) that are listed on KSE (Karachi Stock Exchange). Data is collected from financial statement analysis of all the KSE listed nonfinancial firms issued by State bank of Pakistan. Sample consist of 199 firms (149 from textile, 23 from cement and 27 from energy sector) and total years of observation are five 2005 to 2009.



In this study leverage (Lvg) is taken as the measure of capital structure, which is dependent variable. There are different approaches to measure this variable. One method is market value based and second one is book value based. Consistent with previous study of Shah and& Hijazi (2005) on Pakistani non financial firms, I will use book value based measure. …

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